Risky insurance company move also fuels Pa. malpractice crisis

Tim DarraghOf The Morning Call

Editor's note: This is the second in an occasional series that examines medical malpractice and its effect on physicians, patients and hospitals. Today, we look at the fall of a leading malpractice insurer.

As Pennsylvania's medical malpractice insurance crisis reached a peak early this year, doctors and lawyers clashed over which side was to blame for rates raging out of control.

Insurers, meanwhile, managed to stay in the shadows.

On Feb. 1, the bright lights found the insurance industry.

That's when the PHICO Insurance Co., the third largest insurer of doctors and hospitals in the state, collapsed under a mountain of claims it would not be able to pay.

Since the Mechanicsburg, Cumberland County, company's meltdown began, customers across the country, mostly doctors and hospitals, have had to seek new insurers. They found them  offering astronomically higher rates.

Potential malpractice victims have seen their cases frozen, with the possibility of delayed, if not reduced, payment for their claims.

The state's remaining insurers were clobbered, too. They'll be assessed hundreds of millions of dollars for a bailout fund, costs that filter down to consumers in higher property and casualty insurance rates.

And taxpayers will take a hit as well, picking up the tab for a tax break that helps out insurers hurt by the assessments. The cost will reach $34 million next year.

PHICO's implosion showed that allegedly risky and negligent insurance business decisions also have contributed significantly to the crisis.

PHICO's failure also raises questions about the state's role in regulating the $58 billion insurance industry in Pennsylvania. The industry's interests so permeate state government  where the top regulators are insurance executives, and some legislators on insurance committees work in the industry they regulate  that some believe even-handed regulation is impossible.

With its rapid decline, allegedly falsified financial reports and heavy costs to the public, PHICO calls to mind another recent corporate collapse.

''There are, just like Enron, supposed to be traps in place to prevent things like this,'' said state Rep. T.J. Rooney, D-Lehigh/Northampton, a member of the House Insurance Committee.

''PHICO didn't get in trouble last week. This is a slope they had been headed down for a while.''

As in the Enron debacle, PHICO's failure swamped many in its wake. Unlike the Enron case, however, lawmakers aren't scrambling to root out the cause and pass laws to prevent a recurrence.

Neither committee in the state House or Senate that oversees the insurance industry has scheduled a hearing into the matter.

PHICO's history

The PHICO story begins and ends with medical malpractice insurance crises in Pennsylvania. In the mid-1970s, the cost for new malpractice insurance soared, if it was available at all, because major insurers withdrew after mounting losses.

The Hospital Association of Pennsylvania, the state's main hospital lobbying and resource organization as it was then known, pooled its resources to form the Pennsylvania Hospital Insurance Co. That entity in 1976 would become PHICO.

In the eyes of Business Insurance magazine, in those early years, PHICO was a ''conservatively run stodgy'' company.

That began to change in 1995, when a new regime started taking over. Carolyn F. Scanlan, the president and chief executive officer of what is now the Hospital and Healthsystem Association of Pennsylvania, would become chairman of the insurance company's board.

The year after Scanlan joined the board, Barry Persofsky, an executive at American International Group, was hired to run PHICO. As chief executive officer, Persofsky sought to increase PHICO's reach from Mechanicsburg to every corner of the nation, according to court records and reports from A.M. Best, a top insurance rating organization.

The strategy initially succeeded.

PHICO gained approval to sell in every state. The company's direct premiums climbed from $172 million in 1996 to $269 million in 1999. By 2000, it had bloomed into the nation's seventh largest medical malpractice insurer.

PHICO's vision was simple. The fastest way to grow in new markets was to be the low-price insurance leader.

Lehigh Valley Hospital was among those attracted to PHICO, at least partly because of its competitive rates. From 1995 until July 2000, LVH used PHICO for its primary malpractice coverage, said Georgene Saliba, LVH director of claims and risk management.

But around the time PHICO's revenues were peaking, LVH officials were worrying about their insurer.

PHICO's once-healthy bottom line was eroding. In early 2000, industry watchers began publicly downgrading PHICO's financial rating. ''At that point, we were already concerned,'' Saliba said.

Even though LVH had dropped PHICO by mid-2000, it still counted on the company's protection. Its malpractice insurance, covering more than 200 doctors, was needed to cover claims far into the future  years after the malpractice may have occurred when PHICO was the insurer.

The coverage for which LVH paid in the late '90s really meant that the hospital network had bought into PHICO's long-term stability.

''There's a certain amount of fundamental trust that gets built up,'' Saliba said.

Although PHICO officials disputed the claim, state officials and analysts say the company's growth was fundamentally unsound.

For one thing, PHICO's move into new territories was risky. Familiarity with markets is vital to setting proper rates, the experts said, as each area has unique regulations, markets and competitors.

''Each state is very different,'' said former Pennsylvania Insurance Commissioner Cynthia A. Maleski. ''Before you set foot in one state, you really have to know what you're talking about.''

PHICO's underpricing also could be substantial. One advertisement from 1997 lured doctors in a Missouri medical society to PHICO by claiming savings of 25 percent to 35 percent on medical malpractice insurance.

PHICO appeared to write policies simply with a view toward collecting the premium, but without full regard of the risk, company insiders told the state Insurance Department, according to department spokeswoman Rosanne Placey.

With the stock market soaring and payments far off, analysts said, it was common during the boom years of the late 1990s for insurance companies to focus on new revenues and worry about claims later.

Pricing medical malpractice insurance is tricky business. Medical mistakes may not result in a court judgment or settlement for years. An insurance company may not have to cover a malpractice claim for seven or eight years after the premium was paid, said Carol Brierly Golin, editor and publisher of the Medical Liability Monitor, an industry newsletter.

Other insurers tried to compete on price with PHICO until they realized they couldn't make money.

''Other carriers in the industry saw it and adjusted their rates,'' said Larry Smarr, president of the Physician Insurers Association of America. '' Unless PHICO was doing something magical, their rates were deficient.''

Increasing PHICO's risk was the marketplace itself, which at the time was unusually favorable to buyers. According to industry observers such as Golin and Smarr, medical malpractice insurance had been a profitable line of business in the early 1990s.

More companies saw there were profits to be made, entered the marketplace, and ''we had a price war,'' Smarr said. Now, with the consequences of that price competition cutting deeply into the industry's profits, insurers are leaving the market or, if they are staying, raising rates.

PHICO fell into a third category. It crumbled under millions of dollars in claims.

The numbers tell of PHICO's meteoric rise and crash.

From 1996 to 1998, for instance, PHICO paid out about 83 cents in claims and expenses for roughly every dollar of premium income it received.

In 1999-2000, the company paid out $1.48 for every premium dollar it received.

PHICO's slide toward financial peril hardly stemmed the flow of cash to company officials. From 1998 to 2000, Persofsky's salary rose by $100,000 to $400,000. He received five- and six-figure bonuses each year, with total compensation topping out at more than $534,000 in 1999.

Meanwhile, the board continued to authorize dividends to PHICO's parent company, the PHICO Group. State officials verbally chastised PHICO for releasing the dividends  part of which ended up in the directors' pockets  while the company's finances slid.

For example, the compensation for board member Robert F. Nation of Hummelstown, Dauphin County, reached nearly $64,000 by 2000.

Did PHICO know?

Company officials knew by September 1999 that PHICO was hemorrhaging money, the state Insurance Department argues in a lawsuit filed against the PHICO officers and directors late last year.

By early 2000, the state alleges, PHICO had three separate opinions recommending that it increase its reserves  the funds it puts aside to pay claims  by $90 million to $135 million, a situation the state calls ''a crisis of enormous proportions.''

In response, the officers and directors have either denied knowing how sick the company was or blamed the decline on outside forces.

The next two years, PHICO drained itself financially, and losses continued, primarily because of the company's expansion into new markets during Persofsky's term, A.M. Best and state officials said.

PHICO's officials ignored auditors' warnings about its underwriting and pricing practices, the state charges. Board members and company officials declined to comment, citing the state's lawsuit.

Top company officials, in court papers filed in response to the state, indicate that they were unaware that the pricing strategy was inadequate or that they had orders to follow. Senior Vice President Mark O. Mitchell, who is among the defendants, said he ''would simply be fired if he spoke to the full board'' about his concerns, court records say.

Other defendants, including Scanlan, argued in answer to the state suit that PHICO's pricing was adequate for the marketplace and that they believed ''diversification'' would help the company.

By last spring, PHICO's perilous financial state reached a crisis point.

One industry watcher, Weiss Ratings Inc., uses a grading system similar to the A, B, C structure in schools. PHICO, it declared, was no better than a D by the middle of 2000, said Weiss' Stephanie Eakins. By the end of the year, she said, it was a D-.

PHICO's board took notice, too. It fired Persofsky last April and replaced him with another board member, Constance Foster, a former top state Insurance Department regulator.

Finally, PHICO's reported 2001 second-quarter surplus of $6.8 million  down an astounding $120 million from the beginning of the year  forced the state to act. Under industry guidelines, the department had to put the company in ''rehabilitation'' last August, when the company released the quarterly report.

Simply stated, PHICO didn't have enough money to pay future claims.

Meanwhile, current and former PHICO Group directors received payment for their services until the state intervened in August. Five PHICO Group directors, including former Easton Hospital CEO Officer Donna Mulholland, each received a payment of more than $1,000 the day before the state received PHICO's disastrous 2001 second-quarter report, according to court records.

Persofsky received a $215,243 payment in June, two months after being fired. Scanlan received three payments in 2001 totaling $56,250 by July 26, records indicate.

PHICO Group filed for bankruptcy in December.

Even before the full picture of PHICO's crash became apparent, state officials struck back at the company.

The Insurance Department in November 2001 filed the lawsuit against Persofsky, other company officials and the board, including Foster, the former state insurance commissioner; Scanlan, PHICO's board chairwoman; and Vice Chairman Donald R. Creamer, the former president and chief executive officer of Susquehanna Health System, Williamsport.

While the state tried to salvage the company, an analysis of PHICO's books revealed finances allegedly were worse than reported  much worse. PHICO had a $250 million deficit by the end of the first quarter 2001, not the $6.8 million surplus, the state said. Placey said financial statements the company gave the state Insurance Department ''were completely inaccurate.''

Attempts to salvage PHICO would be futile, state Insurance Commissioner M. Diane Koken said. The state announced Feb. 1 that it would liquidate PHICO.

The demise of PHICO insurance immediately reached the Hospital & Healthsystem Association of Pennsylvania, a subsidiary of the Health Alliance of Pennsylvania, like PHICO Group. PHICO had contributed $3.3 million by 2000 to its parent corporation.

PHICO Chairwoman Scanlan, president and CEO of the association, had her salary paid partly through income from PHICO. Scanlan's total compensation from the association was $407,851, according to 2000 financial reports.

''PHICO obviously was a cash cow for them,'' said John H. Reed, director of the state Medical Professional Liability Catastrophe Loss Fund, the CAT Fund. '' They wanted them to go forth and multiply to produce dividends.''

The crash also weighed on institutions such as LVH.

''Are we happy? Absolutely not,'' said LVH's Saliba. ''And it's hard to understand how it could happen.''

Searching for answers

As the dust from PHICO's crash begins to settle, lawyers for PHICO officials say the company was a victim of a brutal marketplace and inadequate regulation.

Persofsky performed his job competently, O'Brien said. ''Now they say he didn't write his premiums high enough literally to ensure that they would withstand the firestorm He raised lots of premiums To the dismay of the clients they serviced, who were dumbstruck by some of the increases. Now the liquidator says, You should have raised them higher.' ''

Just before Persofsky was fired, reports said, PHICO sought approval for a 40 percent increase in liability rates.

PHICO, O'Brien added, was a victim of a severe swing in the medical malpractice insurance market. ''Now because of the medical malpractice crisis,'' O'Brien said, '' the commonwealth of Pennsylvania is going to attempt to lay off the entire crisis of medical malpractice on Barry Persofsky.''

Other defendants' responses to the suit also claimed that the company's business decisions were reasonable, but ''rendered unsuccessful by subsequent changes in the insurance industry and the external business climate,'' as Mitchell's response said.

Competition may have driven insurers into greater risk, said Geri L. Riley, a vice president of research at the financial research firm Conning & Co.

''There were rating agencies that encouraged med-mal' insurers to diversify,'' she said. More numerous and larger claims against insurers and declining investments also worked against PHICO, she said.

Persofsky also turned the tables on the Insurance Department, claiming it ''failed to take necessary steps to insure continued viability'' of PHICO, court papers say.

''The Insurance Department was well aware, well aware of what work was being done by PHICO in the late '90s,'' O'Brien said. ''This was a fully disclosed situation every month of every year,'' he said. PHICO was required, as all insurers are in Pennsylvania, to file quarterly and annual reports to the department.

Regulators respond

The Insurance Department, whose primary job is to ensure the solvency of insurers, at least sensed things were wrong at PHICO. As evidence the state was aware of PHICO's downward slide, Placey, the department spokeswoman, cited an order to halt the distribution of dividends in March 2000 and the decision to have outside auditors review PHICO's reported reserves in 1999, 2000 and last June.

The guidelines required that the state intervene more by conducting examinations or analyses as the numbers continued to plummet. The department did demand that PHICO file a plan to restore its financial health, which Placey said it reviewed.

The department, however, did not conduct an examination of PHICO during the company's decline. Regulations require the department to schedule an examination of insurance companies a minimum of once every five years. PHICO's next scheduled examination was to have been this year, although the department could have demanded a look at PHICO's books sooner.

The lack of independent verification of PHICO's financial reports was critical.

The lawsuit against PHICO outlines why: The company's statements were false, it says. Officers who knew or should have known that PHICO was on the ropes failed to disclose the extent of the danger, it says. The board also ''completely failed'' to oversee operations properly, Placey said.

As in the Enron collapse, questions have arisen about the adequacy of PHICO's audits. A representative of Tillinghast-Towers Perrin, a management consultant that reviewed PHICO's 2000 annual statement, threatened to withdraw its opinion supporting the statement five months later, Placey said.

The 2000 annual statement does say that Tillinghast's actuarial consultant, Ollie L. Sherman of Arlington, Va., relied on PHICO's senior vice president and actuary, William E. Burns, ''as to the accuracy and completeness of the data.'' Burns could not be reached for comment.

Information PHICO provided was ''factually incorrect,'' Sherman told the state last September.

State officials have interviewed Burns, Placey said, but have not decided whether to assert a claim against him.

A Tillinghast spokesman declined to discuss the firm's certification of allegedly inaccurate statements.

The state's role

Observers say the fact PHICO could fall so far without state intervention is indicative of how weak insurance regulation can be. ''One thing about insurance is it's regulated by the states, and I think the insurance companies like that,'' said David Schiff, editor of Schiff's Insurance Observer.

''The department was lacking in their oversight of PHICO,'' said Rep. Rooney, 133rd District. ''The department is not pure in all of this.''

He said ''bargain basement'' prices depressed income into the CAT Fund, which provides a second level of insurance for health professionals and assesses fees based on market rates. ''Some of these carriers are losing significant sums of money in this process, which does not bode well for the long-term stability,'' he told lawmakers.

State Rep. Steven Nickol, R-York, a past critic of insurance industry practices, said he is ''very concerned'' about cases like PHICO's. But Nickol, a House Insurance Committee member, was unaware of key elements in PHICO's case, such as the department's allegation the company filed falsified records.

He has since inquired about holding hearings into PHICO's collapse, but none is scheduled. The state Senate Banking and Insurance Committee  which, like the House committee, has three members who are licensed insurance agents or brokers  has no plans for hearings either.

Sen. Michael O'Pake, D-11th District, wants to get the insurance industry and regulators into the debate that until recently had been the province of doctors and lawyers. O'Pake has called for a Joint State Government Commission study to explore the root causes of the latest insurance crisis in Pennsylvania, where only a handful of medical malpractice insurers remain.

''We can't turn our backs on the internal financial mismanagement that drove dominant insurers out of the market,'' he said, ''or why the Insurance Department did nothing to prevent that from happening.''

Days before O'Pake introduced his resolution calling for the study, the state took control of two more financially ailing insurance companies.